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Outside View: Oil Prices And Recessions Washington (UPI) Aug 29, 2005 Many people have been asking: Will higher oil prices cause a recession? How much will oil prices slow growth? First, we should agree on terms: Economists define a recession as two consecutive quarters of negative growth (growth for the whole year could still be above zero). Economists don't have a standard definition for a slowdown. Let's say economic growth of less than 2.5 percent for two consecutive quarters. That would be about 1 percentage point below the 2005 second quarter growth rate, and would likely cause unemployment to start rising quickly. At present rates of productivity growth, even a reduction in gross domestic product growth rate to 3 percent would likely push up unemployment, but how much depends on productivity growth. Second, how much oil prices affect the economy depends a good deal on the Federal Reserve and the China's monetary authorities. The Fed has been pushing up short-term interest rates to slow the economy and curb the threat of inflation; until now, this has had little effect, because China's purchases of U.S. dollars and securities to maintain its yuan at 8.22, and now 8.10 per dollar, have caused U.S. long-term rates, including mortgage rates, to rise much less than the target federal funds rates. Now, higher oil prices both are pushing up inflation and will likely slow growth too. How will the Fed react? Will higher oil prices cause it to back off raising interest rates or pursue higher interest rates more aggressively? Will Chinese actions continue to subvert the effects of Fed policies on long-term rates. Without going into all of the machinations of U.S. and Chinese central bank interactions, what is important is that the impact of higher oil prices on the U.S. growth will depend on how interest rates--especially, mortgage rates--move over the next weeks and months. Morici's Bottom line: A recession will require at least a 1.25 percent increase in mortgage rates to above 7 percent and an increase in the price of oil to around $80 per barrel. An economic slow down will require at least one or the other. My Thinking: Lets take out "the other hand" out by assuming nothing else happens that is wholly disruptive - e.g., a coup in Saudi Arabia, or China dramatically altering its exchange policy and abandoning the dollar. Then, the near term outlook for the economy can be boiled down to short-term rates (commercial rates and credit card interest rates), mortgage rates and oil prices. Commercial Interest Rates: I am not worried that much about commercial rates, unless those rocket. Right now the rates on short-term money are not that high, and we are probably looking at another one half to one point increase over the next 24 weeks. It's a cost of doing business; if demand stays strong, carrying costs get passed along. Like energy prices and wages, higher carrying costs can be made up by boosting productivity and tightening inventory management. It really comes down to how well consumer demand holds up, which brings us to the two key consumer interest rates. Credit card interest rates could probably stand to go somewhat higher as long as mortgages stay affordable. We really don't know how much higher credit card rates have to go to become a problem, because we don't know much payment burden consumers can carry. Quite simply, history has been no guide. Consumers seem to find ways to wiggle out, namely through the machinations of the home equity market. Mortgage Rates. What really matters is the mortgage market--both rates and terms. As long as housing prices don't go down, consumers have more equity they can borrow against. If mortgage rates go up another 1.25 or 1.5 percent and pierce 7 percent, watch out. That's when the housing bubble bursts? Then consumers would cut back on spending a lot. Oil Prices: Oil prices have not peaked in inflation-adjusted dollars. From December through June, oil prices increased from about $40 to $55 per barrel (monthly averages), and those have increased about another $10 or so since that time. Oil prices would have to reach $75 or $80 per barrel before I would worry, if oil prices inched up as they have been doing. However, if the Saudi regime fell and oil went to $80 or $90 overnight and stayed there, that is a very different story, but oil inching up another $10 to $15 is manageable. Note from mid December to the end of July, oil increased $21 per barrel and regular gasoline increased 44 cents to $2.33 per gallon. Another 57 cents would increase the price of regular by 24 percent and add only about 1 percentage point and change to the CPI. We could absorb an increase like that without risking a recession. Going Out on a Limb: I believe the economy will post solid growth in the third quarter (better than 3.5 percent) but that we are due for modestly slower growth (growth around 3 percent) in the fourth quarter or early next year. However, a real slowdown, as defined above, in my estimation, would require mortgage rates to rise 1.5 percent or for oil prices to pierce $75 or $80 per barrel. A recession would require both. (Peter Morici is professor at Robert H.Smith School of Business, University of Maryland.) (United Press International's "Outside View" commentaries are written by outside contributors who specialize in a variety of important issues. The views expressed do not necessarily reflect those of United Press International. In the interests of creating an open forum, original submissions are invited.) Related Links SpaceDaily Search SpaceDaily Subscribe To SpaceDaily Express Purdue Creates New Method To Drive Fuel Cells For Portable Electronics West Lafayette IN (SPX) Aug 29, 2005 Engineers at Purdue University have developed a new way of producing hydrogen for fuel cells to automatically recharge batteries in portable electronics, such as notebook computers, and eliminate the need to use a wall outlet. |
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